Aeropostale: Could Have Been Better
Board: Hidden Gems Aeropostale
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Aeropostale’s share price has benefited from a long series of giving lowball guidance and then over-delivering on results. This is not an unusual tactic and companies giving conservative guidance are not anathema to investors. Conservative guidance is preferable to promising results the company has no hope of seeing. Gratification is often immediate as the share price increases on optimistic guidance, but a disappointed market will mercilessly kill a company for misses—- especially now.
Tom Johnson, CEO of Aeropostale has been anticipating the worst-case scenarios every quarter for three quarters and then beating by a dazzling margin. The result was delayed gratification and ARO took off from $9 after some particularly negative guidance to over $22 in April as Q1 2012 beat expectations once again. Q2 2012 was a different story.
Four Quarters of Guidance
Q3 2011 guidance from the Q2 2011 conference call
For the third quarter, earnings per share was guided in the range of $0.9 to $0.15 per diluted share. This guidance assumed a share count of 82 million.
Trends had improved slightly since the second quarter, but they believed “it is prudent to take a cautious view of the third quarter and the remainder of the year” with volatile macroeconomic and competitive environments.
As it turns out, Q3 (includes back to school) was not as bad as guidance made out. After they pre-announced actual Q3 earnings the first week in November, ARO went on to $17 from lows at $9 as the forecasted 9¢-15¢ turned into 30¢ in earnings---double the high end of guidance.
Q4 2011 guidance and Q4 2011 results
Guidance for Q4 2011 (includes Black Friday and Christmas) predicted continuing negative same store sales and compressed margins. Projected EPS was $0.35-$0.38 compared to $0.95 in Q4 2010 –- it looked fairly bleak. Actual EPS (adjusted for non-cash impairment) for Q4 2011 was $0.44 again decimating guidance. ARO shares increased to $20.
Q1 2012 guidance and results
The run of positive surprises extended into Q1 2012.
EPS was expected to range between $0.08 to $0.10, compared to earnings of $0.20 in Q1 2011 -- 50% less than 2011. In spite of the guidance, ARO’s price per share did not drop as the market was anticipating a positive surprise. I was guessing they would come in at 13¢ per share and they did.
Q1 2012 comps, including e-commerce improved 2%. The average unit retail and sales per transaction were both positive for the quarter and earnings were 13¢ rather than the initial guidance of 8¢-10¢. The price per share reached its zenith at just over $23 in April.
All good things must come to an end especially if you are a pessimistic realist
Q2 2012 guidance from Q1
From the CEO:
I will now discuss our guidance outlook. While we continue to make progress against our strategic initiatives, uncertainty remains surrounding macroeconomic conditions in the overall promotional environment, particularly as we enter the key back-to-school selling season. Accordingly, we are providing second quarter guidance in the range of $0.03 to $0.05 per share.
This was another in a series of very muted guidance announcements. ARO only earned 4¢ in Q2 2011 on (14%) same store sales and it’s easy to see Johnson was not setting the bar high. He may have been anticipating another small positive surprise in Q2, but he and the market were doomed to a negative surprise disappointment. The price per share is now around $12.
And that brings us to the disappointing Q2 2012 results
Revenue was $485.3 million up 4% year-over-year. Since the increase in total square feet was 4% and same store sales were flat, this is a company treading water. The good news is that increased stores and square footage did not lead to sales decreases. The flat results were built on e-commerce increases and without e-commerce, same store sales were a (1%).
Comps included a 5% increase in units per transaction offset by a 4% decline in transactions and a 1% decrease in average unit retail. Translation is that fewer customers were buying heavily discounted merchandise. While Johnson is saying that ARO product is fresh and new and fashion is flying off the shelves, the core product is still failing to keep customers buying at historic prices and amounts. The company has lost its pricing power and appeal as a shopping destination. It’s the low price that is keeping them alive.
Gross margins are still ugly and were 25.3% versus 24.4% last year.
SG&A for the quarter was 25.2% of sales versus 23.2% last year. The 2% increase was driven by higher advertising costs not offset by better store performance and increasing e-commerce costs set against slower e-commerce growth. ARO hired Chloe Moretz of Hugo and Dark Shadows fame as a fashion spokes person.
[See Post for Tables]
The compressed margins from 2011 continue into 2012 with the second quarter again lower than the company would like. ARO missed more than EPS guidance -- it failed to improve gross margins as raw materials pricing eased and continued to survive on promotional, margin-eating pricing. For Q3, promotional pricing and competition are again pressuring gross margins and revenue.
ARO's inability to find positive comps over last year's weak sales highlights just how bad business is now.
Gross margins are not expected to improve much from Q2 as the back half of the years goes on – predictions are for slightly less than a 1% increase.They do expect around 0.5% improvement in operating margins as marketing cost eases. However, store operating systems and incentive and bonus expenses consume more SG&A than marketing and those are not going to decrease. ARO is counting on gross margin expansion to make the bottom line more palatable.
PS stores are not profitable yet and cost 2¢ in earnings to run.
Marc D. Miller – CFO
Sure, Lorraine, I'll take that one. While we don't breakout P.S. financials separately, what we said in the past is that on average P.S. is about $0.02 per quarter hit. Clearly it's higher in the first half of the year, lower in the back half of the year as you have the sales build. So, overall, we've said also that at about 100 stores operating on a full year basis, that's our target internally for achieving breakeven.
What is fashion for us, the Fashion Impaired
We finally get to hear what fashion means in Aeropostale-speak. Tom Johnson spent several conference calls telling analysts that ARO was going to hit fashion harder without explaining exactly what that was.
The core products are graphic tees/henleys, hoodies and denim. It has not been selling well as the core customer quit buying the logoed hoodies and tees that ARO held onto too long. To counteract core customer boredom, ARO moved on to fashion. Fashion was colored denim (now fashion basic) and patterned denim (still fashion). The core remains blue denim.
For tops, it appears that logo is still core and that fashion is now the midriff silhouette, long tapered silhouette and bolder graphics; scooped necks and spaghetti string straps. The ever-bold American Eagle (NYSE:AEO)has a large selection of plaid not offered as fashion in such quantity at other retailers. Francesca’s gives plaid a miss. ARO is missing the trend and does not have the bold colors, stripes and geometrics of a fast fashion leader like Francesca’s (now at a 52-week high). It doesn’t carry much of the tapered long line silhouette and its mid-riff is boxy. Necklines do not stray far from tee shirt-like. The selection of colored denim is limited and there are just one or two patterned denims.
This quote from the CFO makes it clear they are now seeing where the miss was. They are just a few quarters too late. The push to fashion needed implementation in late 2010 just when Johnson was taking over as CEO, Julian Geiger’s influence was disappearing and the shelves were deeply stocked with logos and blue denim. Johnson had no fashion sense.
Marc D. Miller CFO
We look at the 2006 through '07, '08, '09, what we recognized is obviously a significant dependency on the logo product within the store, and at the time the uniform for that girl was very much dependent on logo product. Everybody was selling logo product. And the one thing that we probably were at (fault of) is not interjecting more fashion into our assortments and that's just what we have to do and what we're doing.
I think the risk of the business is not evolving that component of the businesses. It is far greater than adding the fashion. So, what you're looking for and what we're anticipating and striving to do is strike that right balance and that's what's most important to us. We think that even though some of those years are very strong and it was dominated by logo product, we know that we are doing it off of quite a bit of price and the price, because of the size of the buys, it is advantageous for us and we would get sales from it, but on slightly lower margins year-after-year. What we needed to do is evolve. We didn't evolve fast enough and we're evolving now. What we are all looking for is to strike that right balance, and I think that you will see at over time continue to grow.
The CEO is seeing the decreasing importance of the core to increasing profits in the future. Does this portend a shift away from the longstanding ARO model of follow the fashion? And if so, does ARO have the talent with the chops to pull off fashion coups? To date, they have not been able to make the core work and the foray in to fashion is limited mainly to colored denim that by most accounts is getting a bit long in the tooth and patterned denim that has not proven to be a successful fashion trend. The Buckle is limiting its colored denim, believing that it will not continue to outperform and has no patterned out of 1400 styles on line. Francesca’s has mainly bright colors and patterns.
Thomas P. Johnson
I'm not going to get into the percentages, but clearly it's an opportunity for us to be build upon and we know that if you bucket the fashion date, we call fashion basic and fashion over time, that component of the business will continue to grow and like I said earlier, core will never go away, but it will diminish over time.
These are dismal numbers and there is no way to spin it positively. The only thing pushing the price back up was the string of positive surprises engineered by the CEO. The last time ARO had positive growth in revenue, gross, operating income and net was two years ago. Since then the company has been in a state of steady decreases for operating and net income. Almost two years worth of negative same store sales are an indication of Aeropostale’s problems. This period of decline coincides with the change at the top. We can’t put the blame on the CEO solely but it’s a place to start. To date, Johnson has shown little talent for spotting trends and acting on them.
A couple of actions I generally take as a bad sign and an attempt to manufacture growth as retailers hit US saturation are the introduction of new concepts and international expansion. PS as a standalone concept is still not profitable and ARO continues to open PS stores hoping to break even at 100 units.
They are also continuing international expansion through licensing. This is less risky than store ownership and does not expose them to operating losses—they just collect the fee. Of course the flip side is if the stores are a huge success, the upside is capped. Abercrombie & Fitch has had trouble with stores overseas paying their way and making money. ANF owns their stores.
ARO is now at 20 international stores and will be in five different countries by the end of the quarter. Panama and Columbia are the next expansion. ARO will have 25 stores at the end of 2012 and 50 at the end of 2013. Since they do not break out separate numbers we have only their word they are doing “really well.”
A few positives
Inventory is under good control and the discounted liquidations have helped clear the shelves. Inventory at the end of the quarter was $247 million, down 1% in total or down 6% on a retail per square foot basis.
Cash and cash equivalents at the close of the quarter were $170 million versus $73 million last year. There is still no debt.
The core of denim and logos is under promotional pressure again in early back to school. And ARO is predicting that both revenue and margins will decline/contract in the third quarter. Earnings per share are estimated in the range of $0.25 to $0.30. This guidance assumes a share count of 81.7 million and a tax rate of approximately 40%. There were 81.07 million diluted shares in Q3 2011. Earnings per share were 30¢ in Q3 2011 and same store sales were (9%). That would make guidance flat at best and (16%) growth in EPS at the low end.
This does sound like a worst-case scenario. If Aeropostale manages another positive earnings surprise, then Q3 will usher in potentially large share price appreciation. Since Johnson has played this card at least three times over the past four quarters, and only had it bite back in Q2 2012, odds are he is low-balling again. If ARO’s fashion sense continues to fail and the core does not catch fire (figuratively) then he may be in for a negative surprise. Because his guidance has been inaccurate in the past year, it’s impossible to tell which way ARO will go in the short term. For me to get interested in investing, I would like to see Johnson replaced or at least bring back a fashion-knowledgeable co-CEO again.
Maybe because it's a hold no coverage is provided. I have been covering ARO since last fall. This makes the third or fourth quarter I have spent with Tom Johnson and the guys. I still am not impressed that he has learned much. I refused to buy last fall when it fell to $9 on gloomy guidance and was appalled and frustrated at his series of lowball guidance that was superseded by positive surprises and sent the price up around 2 1/2X--a double I missed.It would have taken some sweet timing to get in and out. I did not mistake the price appreciation for real progress because the numbers were still horrible and he was still CEO so I was still not a buyer. IMO he reaped what he sowed in Q2 2012. Now he actually needs to get the business in gear.